10 September 2011

Hey Europe, What Is Going On? (Part 5)

Part 4 of this series was about interdependencies within Europe. In this article we explore how Europe and especially Eurozone relate to the rest of the World. Why? Because this crisis in Euro area is bound to lead to either of two: something that might be called as the United States of Europe, or collapse of euro. Of course, if the first is to happen, some countries are likely to be dropped on the way and others may join. We want to get a better idea about which outcome makes more sense and which outcome is more likely given the interests of individual countries. Therefore we are not only interested in the parameters of Germany, France, Italy, Spain, Greece, Ireland, Portugal and so one, but also how the so-called United States of Europe would look in international comparison. 

Let me make a side note here. If you think that the United States of Europe is something very hypothetical, take a look to these news articles for example:
* Debt Crisis Leading to 'United States of Europe?' in CBN News (September 07, 2011)
* Why Eurozone should become United States of Europe, by David Cameron in Dailymail (September 07, 2011)
* Former German leader calls for "United States of Europe" reported by Reuters (September 04, 2011)
You see that current and former decision-makers are talking about this idea pretty seriously.

At least in capitalist economy we always end up with the questions of ownership (Who Owns What?) and debt (Who Owes Whom? Who Owes Whom and How Much? Who Owes What to Whom and How Much?). One general indicator for considering these issues from a country’s perspective (or from the perspective of a group of united countries as Eurozone) is to look at the country’s Net International Investment Position (NIIP) which shows the difference between its external financial assets and liabilities (also referred to as external debt). Both public and private held external assets and liabilities by legal residents of the respective country are hereby taken into account. The calculation is simple:

NIIP = domestically owned foreign assets - foreign owned domestic assets

Figure 1 depicts the development of Eurozone’s NIIP from 2003 to 2010 in billions of euros as well as a percentage of GDP. Being in minus with more than one trillion euros as of at the end of 2010 definitely does not look very good. On the other hand 12.9% of GDP is not as bad as one might expect based on all the current market panic around Europe, especially as this picture has actually improved during the last two years.

In Figure 2 you find the Eurozone’s NIIP broken down by components. As can be seen, direct investments are positive and the minus mainly comes from portfolio investments.

An international comparison of NIIPs of the largest economies (Eurozone, G7 countries, BRIC countries and a few other large economies) expressed as percentage of GDP is provided in Figure 3. In this comparison, Eurozone in total looks somewhat better than US; at the same time there are large variances between countries. Germany’s positive balance clearly stands out (more than plus one trillion euros in 2010). Spain on the other hand appears to have sold a great deal of its assets (in absolute terms, the country’s NIIP was almost minus one trillion euros as of at the end of 2010); indeed – minus 87% of GDP is a large number for such a large country. Not surprisingly, the countries that have more domestically owned foreign assets than foreign owned domestic assets are China and Japan.

What is the above implying when it comes to the discussions around the United States of Europe? Well, Europe as a whole still has potential (assuming that China will not take over during the next few years, financial system will not collapse completely and there will be no major uprising of simple people because of egregious injustice – which all may happen) and it is definitely appealing for European leaders to create a superpower that could surpass US. However, considering the sizes of economies based on GDP figures none of the largest EU countries can be left out; furthermore, it is critically important to get United Kingdom more engaged into the One Europe project (a large question mark). Germany as a large surplus country definitely has reason to claim for a preferential status in the much more integrated Europe which seems to be politically unacceptable for the others.

To summarize our analysis of the situation in Europe so far:
* There is a sovereign debt crisis to solve.
* There is a weak banking sector to solve.
* There are large discrepancies between the European countries and despite of all the efforts (or even contributed by them) these discrepancies are increasing.
* Given the interdependencies between the economies and financial sectors, it is very difficult if possible at all to prevent problems in one country to spill over into another
* With respect to the rest of the World, Europe as a whole does not look that bad as one might think.

Up next in this series: How the European crisis is being “solved”?

(O no, at some point it sounds almost like a conspiracy, although it’s not my intention to be a conspirator but just to analyse the situation...)

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